The United Kingdom and the Czech Republic rationally refused to sign off an a cynical and unattainable EU fiscal compact that supposedly tightens fiscal union. The remaining 25 EU members – including all members of the Euro-zone – agreed to sign the compact. The British Prime Minister, David Cameron, backed away from a threat to veto the use of EU institutions to enforce the new fiscal compact.
Financial markets passed their own judgment on the charade, with the euro losing ground, European stocks declining in value. Portugal’s borrowing costs surged, with the 10-year bond yield peaking at 21 percent. As always, financial markets trump politics as the relevant measuring rod of confidence concerning political deals.
The fiscal pact is a German-sponsored treaty among the 17 euro-zone nations and eight other EU countries. It will require governments to keep their budgets to an average of 0.5 percent of GDP over the economic cycle and to reduce their total government debt to 60 percent of GDP ‘over time’. The EU has long-standing rules that are supposed to limit budget deficits to 3 percent of GDP and government debt to 60 percent of GDP. These rules have never been enforced.
The pact supposedly will empower the European Court of Justice to impose fines on euro countries running excessive deficits. Fines will be capped at 0.1 percent of GDP. Such a fine would fall within the error term of any national budget.
The pact limits are currently honored largely in the breach. For example, within the euro-zone, only Estonia and Luxembourg ran a budget surplus in 2011. Only Finland, of the remaining 15 members, ran a budget deficit within the new pact limits. In 2011, the average euro-zone deficit amounted to 3.8 percent of GDP.
Again, within the euro-zone, only five countries – Estonia, Luxembourg, Slovakia, Slovenia, and Finland, complied with the 60 percent of GDP debt limit in 2011. The average euro-zone debt to GDP ratio ran out at 88 percent.
Note that Germany, the architect of the fiscal pact, failed to comply with either limit in 2011. What are the chances of the European Court of Justice ever fining Germany and France in the order of tens of billions of dollars per annum for budgetary indiscretion? And where would the money be channeled, should such an extraction occur?
The EU (minus 2) pact reminds one of a not untypical situation that arises in any major tourist city where ordinances against prostitution are enacted. A city police car drives up to a hooker soliciting business by the kerbside. ‘Out of business immediately; or we’ll throw you into the slammer,’ shouts the ‘bad’ cop from the nearside window. ‘Meet you round the block, honey; don’t keep us waiting,’ whispers the’ good’ cop on his cell phone, from the passenger seat of the car.
All the parties involved completely understand the nature and intent of the new ordinance.